Hidden Treasure - April 2021, Issue 15 April 2021

Energize Your Portfolio with this 'Essential'

Infrastructure Stock

In this Report:
A proxy play to ride the upcoming capex and infrastructure revival

Don't miss the recommended allocation and buy levels.

The second wave of Covid and lockdowns is here.

The streets are deserted again. While there is a fear in the mind of a common man, the markets seem to be
shrugging it off.

Once again, the focus is on 'Essential stocks' - the businesses in food, FMCG and pharma that are likely to function
uninterrupted, may be even get stronger.

When Covid was still an unknown last year, most of the stocks we had chosen from this space went on to deliver
strong returns.

However, this wave is different.

You see, a year ago, the markets were pricing in the potential risks.

Most of the 'essential' and safe stocks were available at bargain prices. That's not the case this time.

With valuations not offering enough comfort, it's critical to assess if the strong businesses will also end up
delivering strong returns.

A case in point is Hindustan Unilever Ltd.

I am sure initial thoughts which come to your mind is 'safe stock' or 'quality company' or may be 'stable returns'.

Let me share some interesting facts about it.

From 2002 to 2010, HUL's stock price went nowhere. The stock went into an 8 year coma indeed. The returns could
barely even make up for the in ation.

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 A Journey of No Returns in a So Called Safe Stock

You see, a safe and steady business does not always make the cut for great investments. Your investment returns,
at the end of the day, depend upon the price at which you enter and the potential upside.

Now here's another interesting fact to take note of.

Had you instead invested in the BSE Capital Goods index in 2002, you would have made a return of over 3000% - a
whopping 83% CAGR (compound annual growth rate) - over the next six years.

A Cycle of Great Returns

Now let's shift our focus on what happened in the next decade (2010-2020).

Over the 2010 to 2020 period, betting on HUL could have fetched you a whopping return of 30% CAGR, while the BSE
capital goods index mimicked what HUL had done in the previous decade.
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A dismal 3% CAGR!

That's the thing about cyclicality.

You see, the Indian economy was booming in the previous decade (2000-2010). Gross capital formation was
growing at a fast pace, with government's focus on infrastructure and capital spending. We were in the middle of a
global commodity and infrastructure bull run.

Indeed, the stocks in the segment witnessed higher delta and had higher beta. The pace of change in fundamentals
of infrastructure and capital goods stocks led to outperformance.

However, the aftereffects of 2008 subprime crisis and liquidity crisis in the decade ending 2020, put the economy
stocks in a dormant mode.

Investors' interest naturally shifted to the defensive businesses like HUL, leading to healthy returns.

So where are we in the cycle now?

With a declining GDP growth over the past couple of years pre-covid, we believe things have bottomed out.

This is evident from the government's focus on infrastructure, affordable housing, and capital expenditure to kick
start the economy. The progressive PLI (production linked incentive scheme) and 'Atmanirbhar Bharat' push is the
step in right direction.

The government has targeted a US$ 1.4 trillion infrastructure spend over the next 5 years.

Further, a strong momentum in economic indicators like construction equipment sales, record highway construction
run rate, capacity expansion by private players in the cement, metals, and consumer durables gives us con dence of
a strong capex cycle ahead.

So how could one make the most of it this trend?

The obvious answer is to look for fundamentally strong businesses in the capital goods space that are 'essential' to
infrastructure revival.

It will be critical to look for companies that have maintained the integrity of their balance sheet even during a
prolonged down cycle, as these will be best positioned to capitalize on upcoming boom.

Kirloskar Oil Engines Ltd (KOEL) is one such business in our view.

The company is a leading player in the power generation, diesel engine, and pump segments. It caters to diverse
segments such as construction, agriculture, marine, and defense, as well as export markets.

Before we reveal the reasons to invest in detail, let's know more about the company...

About the company

Kirloskar Oil engines (KOEL) is the agship company of the Kirloskar group. It is one of the leading manufacturers of
diesel engines, agriculture pump sets and power generation sets in India. The majority of revenues come from the
below mentioned business verticals, with underlying demand mainly coming from the infrastructure, construction
and agriculture space.

a. Power Generation Business (41% of revenue in FY20)

The company offers the widest range of petrol and diesel power generation sets which are used as power
back up in Industrial (airports, healthcare institutions, metro), residential, commercial establishments,
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 telecom and railways. With 3 decades of existence, KOEL enjoys a strong 34% volume and 23% value
market share in this segment. Besides it is the leader in the small and medium KVA (Kilo Volt Ampere)
Power gensets with a 45% and 37% market share respectively. The company has maintained market share
in a challenging FY20 through newly launched iGreen gensets in low and medium KVA ranges. KOEL iGreen
is the rst to offer IOT (internet of things) enabled genset as a standard feature.

b. Agriculture and Allied Business (16% of revenue in FY20)

This segment comprises diesel engines and pumpsets, electric pumpsets and related oil and spares. KOEL
is a strong player in the pump sets and diesel engines space.

The sale of diesel engines and pumpsets is on a declining trend due to government's subsidy policy and
rural electri cation. But this is getting offset to some extent by use of electric pumps.

To augment its position in the electric pump set industry, KOEL acquired a controlling stake in La-Gajjar
Machinery (LGM) in FY18. The company is also a strong player in the small farm mechanization space, with
tillers and weeders as the 2 major focus areas. With introduction of new products in this space,
management plans to increase the share of agriculture to 35%-40% over the long term.

c. Industrial Engine business (15% of revenue in FY20)

KOEL is a leading independent engine manufacturer in India for most of the Construction Equipment OEMs
in domestic and in global markets. It has a strong market positioning amongst leading construction
equipment players like ACE, Escorts, JCB amongst others. The industrial engine business also caters to
tractors market. The company has recently launched Fire ghting pumps in this segment.

d. Customer support (15% of revenue in FY20)

For any company in the capital goods space, recurring maintenance revenues provide the cushion to the
cyclicality of the underlying business. KOEL's wide spread and digitally connected 421 service outlets
across India, cement its strong presence in the service segment. Share of customer support business
depends on higher sales of power generation sets.

e. Large Engine business

KOEL develops customized products for the defense and marine industry. The supplies include energy
systems for radars, communication systems, battery charging systems, vehicle repowering, propulsion
engines and gensets for Marine segment. Demand is based on launch of large government projects that
have long gestation period and are cyclical in nature.

f. International Business (~7%)

With a view to reduce domestic cyclicality, KOEL is trying to increase its exports to Middle East and North
America. The company's exports of diesel engines, generating sets and spare parts, cover a vast range of
Power Generation, Industrial and Agriculture applications. It has also incorporated a subsidiary KOEL
Americas Corp. to boost sales in the North and South American market.

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 Revenue Breakup

Business segments FY16 FY17 FY18 FY19 FY20

Power Genset Business 34% 35% 41% 39% 41%

Agriculture and Allied business 19% 19% 16% 16% 16%

     Crop Irrigation 16% 15% 12% 12% 12%

     Farm Mechanization 4% 4% 4% 4% 5%

Industrial Engine business 16% 18% 18% 19% 15%

Customer support business 15% 15% 13% 13% 14%

International business 11% 6% 6% 7% 7%

Large Engine business 5% 6% 5% 6% 6%

Source: Company data, Equitymaster

Apart from the above mentioned segments, the company has an investment of Rs 5.7 billion in Arka Fincap Ltd
(earlier known as Kirloskar Capital Ltd). The assets under management (AUMs) for ARKA stood at Rs 11.6 billion at
the end of December 20.

About the Management

Mr. Atul C. Kirloskar, Executive Chairman, aged 60 years, began his career with the erstwhile Kirloskar Cummins
Limited in the year 1978, where he started out as a trainee. He was appointed as the Chairman and Managing
Director of Kirloskar Oil Engines Limited (then known as Kirloskar Engines India Limited) in 2010. He was re-
designated as the Executive Chairman in 2012. He also holds directorship in other group companies.

Sanjeev Nimkar, Managing Director, is also the Vice Chairman on the Board of La-Gajjar Machineries Private Limited
(LGM) - the manufacturer of 'Varuna' Water pumps. He has been instrumental in transforming the company's
business processes as digitally connected customer centric organization since 2012.He has over 25 years of rich
and extensive professional career that spans across diverse industries and companies such as Kirloskar Engines
and Gensets, Philips Consumer Electronics, Philips Lighting, Dulux Paints (ICI), Varuna Electric Pumps and Lafarge
Cement.

Mr Nimkar holds a PGDM from IIM Calcutta, Bachelor's degree in Electronics and Telecommunications from College
Of Engineering, Pune and Post Graduate Diploma in Industrial Law from Symbiosis Law College Pune. He is the
recipient of numerous industry honors for his contribution to the industry in various elds.

Overall compensation of the Key management personnel stood at Rs 151 million in FY20 (8.2% of net pro t), well
below the prescribed ceiling.

Reasons to invest
Strong play on the infrastructure development and capex recovery

Infrastructure spending and capital expenditure (both Private and Public) are expected to propel growth
for capital good companies like KOEL. There had been a lull in capex spending by private sector over the
past 2-3 years, most of which was incurred by the government.

However, the private capex is shown signs of revival. Further, there has been an increased focus from the
government on infrastructure spending. A proposed investment of over US$ 1 trillion towards
infrastructure development - construction of roads, rural/ urban infrastructure, ports and railways will
require power generators and construction equipment vehicles. Beside industrial capex is expected to
further aid growth. KOEL as a leading player in power generation and industrial engine segment is likely to
witness demand for its products with the capex revival. Please note that Power generation and Industrial
Engines business together accounted for 56% of revenue in FY20.
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Restriction on Chinese imports and strong farm incomes to boost farm equipment demand

Agriculture division accounts for 17% of revenues for KOEL. With above average monsoons over the past
3 years, reservoir levels are at a decade high. Besides, a strong kharif season is likely to result in strong
cash ows, boosting the demand for farm mechanization equipment.

Post pandemic, agriculture and allied sectors are focus areas for the government and farm mechanization
trend is likely to strengthen.

The demand for tillers and weeders (2 main product offerings in the agriculture space) is expected to
witness sharp jump with the subsidy from the Government. Structural tailwinds in the form of restricting
import of Chinese farm equipment will lead to further domestic consolidation, bene tting players like
KOEL. The company currently enjoys a 17% market share in the power tiller segment and dominates 15HP
market segment with more than 50% market share. As a leading player, it is well placed to bene t from
rise in farm mechanization.

Strategic acquisition of LGM paying o

The diesel pump segment has witnessed a decline at the rate of 12% per annum on account of increased
availability of power in the rural areas. This has made the company shift focus on the fastgrowing electric
pump segment. In order to consolidate market share in the electric pump segment, KOEL has acquired a
controlling stake in LGM (Gujarat based company) - a strong player in the electric pump space. This has
enabled KOEL to scale up faster with its own agship KOEL electric pump brand along with leveraging the
'Varun'a brand that has a stronghold in the western region.

Industrial engine segment to witness strong construction equipment and tractor demand

Industrial engine segment constitutes supply of tractor engines and engines to construction equipment
vehicles like cranes, backhoe loaders, compacters and rollers. The demand momentum in the tractor and
construction equipment continues to be strong post lockdown on higher infrastructure spends and robust
farm incomes. We believe that with focus on infrastructure spends and government's intent to accelerate
the capex cycle, industrial engine segment for KOEL is likely to witness strong tailwinds. This is evident
from the fact that post normalization in 3QFY21, the segment witnessed a 63% YoY growth. Even players
like Action Construction Equipment which are KOEL's major customers have a healthy order book and are
operating at full capacity to meet demand.

New opportunities in Data center, Metro, Waste Management and Induction Motors

The migration to larger data centers has been accelerated due to COVID. Higher data consumption along
with faster cloud adoption is likely to push demand for power generation sets going forward. India's data
center capacity is expected to grow at a CAGR (Compound annual growth rate) of 21% over FY20-FY25.
As the demand shifts to higher HP gensets (1250-3000 MW), KOEL is at the forefront with new product
offerings to capture the opportunity.

Besides, KOEL has recently won an order to supply power gensets to for the Pune Metro project and is
expected to bid for metro projects in other cities too. Metro order wins will boost its customer support
revenues, apart from contribution in core power generation business.

Another upcoming opportunity at a nascent stage is the waste management space, where KOEL is likely
to offer solutions for cost effective wet waste management.

KOEL has plans to enter manufacturing of induction motors which is an extension to the pump business.

Telecom demand coupled with new product launches to boost Power Gensets business

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 Demand for back up power generators in the Telecom segment had been witnessing a decline over the
past couple of years. For instance, telecom segment for KOEL witnessed a 51% YoY decline in FY20.
Going forward, with the adoption of 5G technology and planned investments in the sector, we expect
demand for power gensets to grow in double digits. KOEL with a strong presence in different horsepower
(HP) segments is well placed to capitalize this opportunity.

KOEL is the market leader in the lower and mid HP segments with a 45% and 37% share respectively. It
has increased its focus on the higher HP segment (200-2000 kw) and gained market share with the launch
of new and innovative products. The current market share in high HP segment stands at 20% and is
expected to increase going forward.

Strong balance sheet to ride the infra and capex revival

Capital goods companies are generally cyclical in nature with strong linkage to IIP (index of industrial
production) and GDP growth of the country. It is very important for a capital goods company to survive in
a downturn, for it to take advantage of the positive turn in the cycle. Most companies struggle with high
leverage levels and go bust in the downcycle.

KOEL has not only survived the downturn but emerged stronger, mainly on account of a strong balance
sheet and marginal debt levels (average debt to equity at 0.1 times for last 5 years). Besides the strong
reserves and multiple revenue streams also bode well for the company.

Key Risks
Unexpected slowdown in the infrastructure and capex spending

Our key rationale for recommending KOEL is based on the infrastructure spending by the government
along with revival in private sector capex. However, any black swan event or slowdown in the above
mentioned spends could delay the recovery. A slowdown in the momentum in housing market could also
slowdown the recovery in the power generation business.

Diversi cation into NBFC business

KOEL has incorporated Arka Fincorp (earlier known as Kirloskar Capital) as a fully owned subsidiary which
commenced operations in April 2019. The management has stated that there is a separate team running
the operations of the NBFC, not affecting the bandwidth of the core business.

Arka Fincorp has started its lending business with a focus on three different segments - Corporate, real
estate and it's getting into SME/MSME Lending. The AUM and loan book of Arka stood at Rs 11.6 billion
and Rs 9.52 billion as on December 2020. Besides the NBFC is pro t making with a net pro t at Rs 120
million for 9MFY21 v/s Rs 30 million same period last year.

KOEL has infused Rs 5.72 billion in Arka Fincorp since its incorporation. Going forward, infusion of
capital from core business in the NBFC will be a key monitorable since NBFC industry is highly
vulnerable to adverse macro developments and could potentially impact the overall performance
of the business. We have been conservative in our forecasts and valuations to account for this
development. However, if executed well, there is also an upside risk (chances of company performing
better than our expectations) to our estimates.

Inability to pass on commodity cost in ation could dent margins

The prices of metals like steel, aluminum, copper which are basic inputs for KOEL have risen over the past
6 to 9 months. Even amid rising demand, inability to pass the rising costs could lead to pressure on
margins. Further, a price push could impact demand for company's products in the short term. That said,

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 KOEL has shown e cient cost management amid challenging times and we expect the company to
navigate the commodity cost better than its peers.

Updates On KIRLOSKAR OIL: Projections and Valuations

Add: Alert | Portfolio
Market Data
Price On Reco. Date (Rs)
CMP - BSE / NSE (Rs)
Change Since Reco.
52-week High/Low (Rs)
We expect the company's topline and bottomline to grow at a CAGR of 4.3%
and 10.0% respectively for FY20-FY23E. With higher capacity utilizations
amid the ongoing capex and infra revival, with expect the operating pro t
160 (BSE)
margin to improve from 8.5% in FY20 to 9.7% in FY21. Our assumptions on
163 / 163 margins have been conservative, keeping in mind the potential impact of
 2.0% rise in the commodity prices.
185 / 95

NSE Symbol KIRLOSOIL

On the basis of these projections, the return on capital employed (adjusted

BSE Code 533293

for tax) stands at 12% , as compared to 10% for FY20, with comfortable
debt to equity position.
No. Of Shares 144.6 m

Face value 2.0

Further, we have been conservative in our valuations to factor in the
CY20 DPS 4.0
diversi cation in the lending business. If the management executes well in
Dividend Yld (CY20 at current 2.5% this segment, there could be an upside risk to our estimates (actual
prices)
performance could be better than projections).
Free Float 40.6%

Market Cap (Rs m) 23,136 Our target price to earnings multiple for the company is 13x (versus current
consolidated P/E of 13.4 x). This compares to median standalone P/E of
Premium Search 15 times for the last decade.
Enter Company Name
As such, we have arrived at a target price of Rs 222 for the stock for FY23.
Rs 100 Invested Is Now Worth This implies a potential point to point upside of 38.4% and a CAGR of
18.1% over next 2 to 3 years (both excluding dividend yield).

The dividend yield on the stock currently stands at 2.5%.

We recommend subscribers to consider buying the stock at current price.

The maximum buy price for the stock stands at Rs 180.

View Updated Chart

Stock Price Performance

Stock Price Performance

(as on 15th Apr 2021)

KOEL Index*

1-Year 57.5% 97.3%

3-Years -23.0% 4.8%

5-Years -8.0% 13.5%

* BSE Smallcap
Returns over 1 year are compounded annual
averages (CAGR)

Shareholding (Dec-2020)

Shareholding (%, Dec-2020)

Category (%)

Promoters 59.4
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 Shareholding (%, Dec-2020)

Institutions 20.8

Others 19.8

Total 100.0

More On KIRLOSKAR OIL

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Action to Take

Subscribers could consider buying the stock of KOEL (Kirloskar Oil Engine
Ltd) at the current price or lower.

The maximum buy price for the stock is Rs 180.

According to us, in a scenario of ideal allocation of funds, small cap stocks should not comprise more than 10% of
one's total equity portfolio. Further, we believe that a single small cap stock should ideally not form more than 2-
3% of the total portfolio. Please note that this allocation will vary from person to person. For something that works
best for you, we recommend you talk to your investment advisor.

Risk Analysis
In order to further improve our risk analysis of companies we have come out with a revised Equitymaster Risk Matrix
(ERMTM). The ERMTM is broken down in to 4 sub heads namely industry risk, performance risk, management risk
and balance sheet risk. (For details please refer to the ERMTM at the end of the report).

Regulatory Risk

Some businesses are subject to regulations by external government agencies. These businesses are
subject to regulatory risk since they do not have the liberty to operate in a free environment. Excessive
regulations can create bureaucratic hassles and impede growth. Thus, higher the regulation, higher is the
risk of volatility in pro t and growth for any business.

For KOEL, regulatory risks are mainly related to emission norms. Just like the automobile industry, the
construction equipment, tractor and power generation industries too have to comply with emission norms.
The new BS IV norms will be implemented from April 1, 2021 that has led to a 15-20% increase in cost of
industrial engines. Apart from the application of BS IV norms, the company also has to adhere to the
pollution guidelines from Central Pollution Control Board (CPCB) for its power generation business. The
above regulations require investment in new technologies leading to higher capex after regular intervals.
For instance KOEL has incurred a capital expenditure of Rs 720-750 million for BS IV and Rs 600-700
million for CPCB norms over the past 2 years.

Besides, demand for products like diesel pump sets and power tillers for agri sector is linked to
Government subsidies, and this in turn has an in uence on the demand of company's products.

With diversi cation into the lending business, the business has become more vulnerable to policy risks in
the last 2 years.

We have assigned a rating of 3 to the stock on this parameter.

Cyclicality Risk

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An industry cycle is characterized by an upturn as well as downturn. Businesses whose fortunes typically
swing with industry cycles are known as cyclical businesses. Cyclical businesses do well during an
industry upturn and vice versa. On the other hand, there are some businesses that are not very cyclical.
These businesses are more immune to changes in industry cycles in the sector and have less risk. In
short, if the business is cyclical higher is the risk.

KOEL operates in an industry wherein demand drivers are primarily linked to the GDP and IIP growth. The
products the company manufactures nd application in industries dependent on infrastructure activities
such as road construction, capex projects and real estate. Besides capex revival plays a very important
part in stimulating demand. Therefore we categorize the company in an industry which is highly cyclical.
Also, the agriculture segment (15% of net revenues) of the country is dependent on monsoons and
government subsidies which affects farm incomes. The nature and timing of both the demand drivers is
di cult to predict.

As such, we assign a high risk rating of 2 to the stock on this parameter.

Competition Risk

Every industry is characterized by competition. However, some industries where entry and exit barriers are
typically low have higher competition risk. Low barriers mean more players can enter the industry there by
intensifying competition.

Competitive intensity in the capital goods industry is more a function of technological expertise and value
engineering. With higher technological dependence to gain market share, the entry barriers are relatively
higher. Also the initial capital expenditure is higher leading to lower number of players. The industry in
which KOEL operates (power gensets, industrial engine and pumps) is a consolidated industry and KOEL
is one of the leading players.

However, MNCs like Cummins in Power Gensets, have strong technological and nancial backing from the
parent company. The pump industry where KOEL is a pioneer, has a higher share of small and fragmented
players. Also the pump industry is more regional and therefore every region has its own dynamics and
competitive landscape.

We have assigned a rating of 4 to the stock on this parameter.

Sales growth

For FY16-FY23E (7 years - actual history of past 4 years and explicit forecast for the next 3 years), we
expect compound annual growth rate (CAGR) at 6.5% for KOEL's topline.

We assign a risk rating of 3 to the stock on this parameter.

Net pro t growth

For FY16-FY23E (7 years - actual history of past 4 years and explicit forecast for the next 3 years), we
expect a net pro t CAGR of 5.9%.

We assign a risk rating of 2 to the stock on this parameter.

Operating margins

Operating margin is a measurement of what proportion of a company's revenue is left over after paying for
variable costs of production such as raw materials, wages, and sales and marketing costs.

A healthy operating margin is required for a company to be able to pay for its xed costs, such as interest
on debt. The higher the margin, the better it is for the company as it indicates its operating e ciency. The
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average operating margins over the 8-year period (actual history of past 5 years and explicit forecast for
the next 3 years) stand at 9.8% for the company.

We therefore assign a score of 3 on this parameter.

Net margins

Net margin is a measurement of what proportion of a company's revenue is left over after paying for all
the variable and xed costs inclusive of interest and depreciation charges. Net margin is the nal measure
of pro tability. It re ects the total pro ts the company takes home. Higher the margin, better it is for the
company as it indicates better pricing power and effective cost management. The average adjusted net
margins over the 8-year period (actual history of past 5 years and explicit forecast for the next 3 years)
stand at 6.0 % for the company.

We therefore assign a score of 3 on this parameter.

Return on Capital Employed (RoCE)

RoCE is an important tool to assess a company's potential to be a quality investment by determining how
well the management can generate returns on its invested capital. A RoCE of above 15% is considered
decent for companies that are in an expansionary phase. The average ROCE (tax adjusted) over the 8-year
period (actual history of past 5 years and explicit forecast for the next 3 years) stands at 11.3% for the
company which we feel could be better.

We assign a score of 3 on this parameter.

Earnings Quality

This measure helps us assess the quality of earnings reported by the company. For instance, some
companies may follow aggressive accounting practices and recognize revenues earlier than warranted.
Earlier recognition of revenues boosts pro ts. However, at the same time they do not generate su cient
operating cash ow (OCF). This signi es debtors are not liquidated on time as sales were booked in
advance. Such companies face working capital issues and their quality of earnings is poor. We assess
earnings quality by dividing operating cash ow to net pro ts. Higher the ratio the better is the quality of
earnings.

The average OCF/net pro t ratio over the 8-year period (actual history of past 5 years and explicit forecast
for the next 3 years) stands at 1 times. This implies KOEL has been able to collect cash in proportion to
the pro ts it generates which is a good sign.

Barring in FY20, the company has reported positive cash ow from operations over last ve years. We
assign a score of 7 on this parameter.

Transparency

Transparency is the key to any business. Transparency can be gauged by assessing the past dealings of
the company with various stake holders be it the customers, suppliers, distributors or shareholders. The
easiest way to gauge the same is checking the level of disclosures in the company's quarterly nancial
updates and communication with minority shareholders. Most importantly, the management's willingness
to explain its stance if there is a negative development in the company or stock shows its forthrightness.

Through regular investor updates via concalls or management meetings, we believe the management is
accessible and open to communication. We also found the management very forthright with respect to
any negative updates on the company or the sector.

As a result, we believe the company deserves a score of 8 on this parameter. /

 Capital allocation

Apart from transparency, capital allocation skills are equally important in assessing management quality.
By capital allocation we mean how the management chooses to deploy capital in the business or across
businesses. Managements that have in the past destroyed shareholder wealth by diversifying in unrelated,
unviable businesses or made expensive acquisitions would rank low on this parameter. Further
managements that focus on capital intensive growth at the cost of pro tability would also fetch a low
rating.

The company belongs to capital goods industry where demand is cyclical in nature and returns on capital
are likely to vary accordingly. Overall, despite being in a capex intensive segment, the company has
managed a robust balance sheet. That said, we are yet to see the execution skills in the lending business
where company has diversi ed in the recent years. We assign a score of 5 on this parameter.

Promoter pledging

Promoters typically pledge their shares to take a loan, which is generally infused in the company. This
exercise is generally resorted to when all other sources of external liquidity dry out. The risk with this
strategy arises when share price falls. This triggers margin calls. If management is unable to provide
some sort of a collateral to the lending party from whom the money is borrowed that party may sell the
shares to recover its money. This accentuates the share price fall. Hence, higher the promoter pledging
higher is the risk.

With zero promoter pledging in case of KOEL, we assign a risk rating of 10.

Debt to Equity Ratio

A highly leveraged business is the rst to get hit during times of economic downturn, as companies have
to consistently pay interest costs, despite lower pro tability. We believe that a debt to equity ratio of
greater than 1 is a high-risk proposition. For KOEL, the debt/equity ratio over the 8 year period (actual
history of past 5 years and explicit forecast for the next 3 years) is negligible and stands at 0.1 which is
healthy.

We assign a score of 9 to the company on this parameter.

Interest Coverage Ratio

It is used to determine how comfortably a company is placed in terms of payment of interest on

outstanding debt. It is calculated by dividing a company's earnings before interest and taxes (EBIT) by its
interest expense for a given period. With negligible debt on the balance sheet, the interest coverage ratios
are comfortable. As a result, we assign a score of 9 on this parameter.

It may be noted that leverage, return generating capability, earnings quality and management risk get the
highest weight in our matrix. Hence, scores assigned to these factors in uence the overall score.

Considering the above analysis, the total ranking assigned to the company is 71. On a weighted basis, it stands at
5.7. This makes the stock a medium- risk investment from a long-term perspective.

ERMTM

Company Speci c Points Riskiness (A) Weightage (B) Weighted

Parameters (A*B)
High-Medium-Low

Industry risk 1 2 3 4 5 6 7 8 9 10
Regulatory risk $ 3 5.0% 0.2

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 Company Speci c Points Riskiness (A) Weightage (B) Weighted
Parameters (A*B)
High-Medium-Low

Industry risk 1 2 3 4 5 6 7 8 9 10

Cyclicality risk $ 2 5.0% 0.1

Competition risk $ 4 5.0% 0.2

Performance risk

Sales growth 3 5.0% 0.2

Net pro t growth 2 5.0% 0.1

Operating margins 3 5.0% 0.2

Net margin 3 5.0% 0.2

RoNW 3 10.0% 0.3

Earnings Quality (OCF/PAT) 7 10.0% 0.7

Management risk

Transparency $ 8 10.0% 0.8

Capital allocation $ 5 10.0% 0.5

Promoter pledging $ 10 10.0% 1.0

Balance Sheet risk

Debt to equity ratio 9 10.0% 0.9

Interest coverage ratio 9 5.0% 0.5

Final Rating# 71 5.7

*Excluding extraordinary gains

For qualitative factors, denoted by $ sign, lower the risk, higher the rating.
For any risk parameter if the score is below or equal to 4 it indicates high risk.
The risk score of these parameters is highlighted in red color.
For risk parameters where the score is above 4 riskiness is low.
The risk score of such parameters is highlighted in grey.

Financials At A Glance

(Rs m) FY18 FY19 FY20 FY21E FY22E FY23E

Sales 30,555 36,264 33,795 31,089 34,820 38,302

Sales growth (%) 14.3% 18.7% -6.8% -8.0% 12.0% 10.0%

Operating pro t (Excluding other 2,654 3,737 2,873 3,420 3,203 3,715
income)

Operating pro t margin (%) 8.7% 10.3% 8.5% 11.0% 9.2% 9.7%

Net pro t 1,397 2,192 1,852 1,839 2,084 2,465

Net pro t margin (%) 4.6% 6.0% 5.5% 5.9% 6.0% 6.4%

Balance Sheet FY18 FY19 FY20 FY21E FY22E FY23E

Current assets (excl current 9,883 10,488 13,214 12,826 11,921 13,075
investment)

Fixed assets 7,321 7,042 7,006 6,607 6,529 6,500

Investments 6,753 7,112 4,326 8,400 9,000 9,800

Other non current assets 1,043 1,312 3,043 3,700 3,885 4,079

Total Assets 24,999 25,954 27,589 31,534 31,335 33,454

Current liabilities excl Short term debt 6,391 6,572 6,631 7,318 7,506 7,939

Net worth 15,755 16,986 17,452 18,596 19,987 21,584

Loan funds 1,395 815 1,494 3,665 1,888 1,977

Other liabilities 1,459 1,581 2,013 1,954 1,954 1,954

/
 (Rs m) FY18 FY19 FY20 FY21E FY22E FY23E

Sales 30,555 36,264 33,795 31,089 34,820 38,302

Sales growth (%) 14.3% 18.7% -6.8% -8.0% 12.0% 10.0%

Operating pro t (Excluding other 2,654 3,737 2,873 3,420 3,203 3,715
income)

Operating pro t margin (%) 8.7% 10.3% 8.5% 11.0% 9.2% 9.7%

Net pro t 1,397 2,192 1,852 1,839 2,084 2,465

Net pro t margin (%) 4.6% 6.0% 5.5% 5.9% 6.0% 6.4%

Total liabilities 24,999 25,954 27,589 31,534 31,335 33,454

Valuations

(Rs m) FY18 FY19 FY20 FY21E FY22E FY23E

Revenue (Rs m) 30,555 36,264 33,795 31,089 34,820 38,302

PAT (Rs m) 1,397 2,192 1,852 1,839 2,084 2,465

EPS (Rs) 9.7 15.2 12.8 12.7 14.4 17.0

Price to earnings (x) 16.6 10.6 12.5 12.6 11.1 9.4

Price to sales (x) 0.8 0.6 0.7 0.7 0.7 0.6

Price to book value (x) 1.5 1.4 1.3 1.2 1.2 1.1

Editor's Note: Please note that the mailbag and performance review report will be shared on 16 April 2021.

Warm regards,

Richa Agarwal
Editor and Research Analyst, Hidden Treasure
Equitymaster Agora Research Private Limited (Research Analyst)

Richa Agarwal (Research Analyst), Managing Editor, Hidden Treasure has over 7
years of experience as an equity research analyst. She routinely scours the small cap
universe for fundamentally strong companies trading at attractive prices. Having
degrees in both finance as well as engineering has served her well in analysing
business models across the small cap space.

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The maximum buy price limit is given in the recommendation report's 'Valuation Rationale' section.

/
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