Areva T&D is re-inventing itself as a complete solutions provider from being more of an equipment supplier.
It hasn’t been great start to the new year for Areva T&D. The transmission and distribution (T&D) equipment player saw its net profit fall by 5 per cent to Rs 51.4 crore in the March 2009 quarter even though the top line was up a remarkable 67 per cent.
Some part of the erosion in the operating profit margins, by nearly 400 basis points to just under 13 per cent, was because of the high cost of raw materials. That was somewhat surprising because nearly 80 per cent of the contracts have price escalation clauses built into them.
Of course, Areva operates across 14 product lines which require a variety of inputs. But it’s also Areva’s changing business model, whereby it is positioning itself increasingly as a T&D solutions provider rather than simply an equipment supplier, that has hurt margins.
Explains Rathindra Basu, managing director, Areva T&D, “We are looking to be a complete solutions provider doing turnkey projects rather than only delivering equipment because that will fetch us more business and a higher turnover. However, in the process we may have to sacrifice margins because margins on such projects are typically 3-4 per cent lower than those on product supplies.”
That means the 16 per cent operating profit margin (OPM) that Areva posted in 2008, which was nearly 200 basis points lower than that in 2007, might be hard to sustain.
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Focus on the top end
But Basu believes that the way ahead is complete solutions especially for high voltage lines--765 KVA and 1,200 KVA. Of the three 765 KVA lines commissioned, Areva has participated in two and moreover, of the fourteen projects announced, six have been won by Areva.
Typically the size of these orders varies between Rs 100-350 crore but margins aren’t very attractive because, as Basu says, the competition is keen –its main rivals are Siemens and ABB.
However, the managing director estimates that by 2012 about 25-30 per cent of the firm’s revenues would be earned from this high voltage segment–765 KVA and 1,200 KVA–compared with less than five per cent currently. Of course all the projects need to be commissioned for Areva to be able to work on them.
Generation gap
Unfortunately, the pace of growth in the Indian power sector has been rather tardy in the last couple of years. As Vinod Chari, who tracks the power sector at Anand Rathi Securities, points out, as against a target of around 11,000 MW that was to have been added last year, only 7,000 MW has been added. While Basu agrees that there have been delays, he’s confident that of the 78,000 MW targetted for the eleventh plan period, about 50-55,000 MW will come up.
He points out that more than the financial closure, what’s taking time are the coal linkages and the acquisition of land. Among Areva’s main customers are Power Grid Corporation, NTPC and Tata Power’s Mundhra plant. The company is being selective while supplying to state electricity boards (SEB) though because payments tend to get delayed.
Economy blues
What Basu’s more concerned about right now is the slowdown in some infrastructure projects especially in the retail and airports segments and also slow progress in sectors such as steel.
“We don’t see a turnaround in these segments very soon, perhaps they’ll revive by the end of the year, he says. Areva’s order book at the end of March 2009 was fairly strong at close to Rs 4,200 crore, an increase of 38 per cent year-on-year, and around 1.6 times CY08 sales of Rs 2,641 crore. However, it’s possible not all these orders will be executed because some of the firm’s clients are facing a cash crunch. As such, Basu doesn’t rule out a slower sales growth than targetted by it, because of these delays.
Nevertheless, Areva is on track to double its capacity from 15,000 MVA to 30,000 MVA by 2012 across eight factories including Vadodara (3 factories), Hosur (1 factory) and Padappai (3 factories). Some of the capacity has already been commissioned.
Subdued profits
That’s one reason why Areva’s net profits are likely to be subdued till the end of the year. It is incurring a capital expenditure of Rs 950 crore over three years between 2007-2009.
| A LONG-TERM BET | |||
| (in Rs crore) | CY08 | CY09E | CY10E |
| Revenue | 2,655 | 3,300 | 4,300 |
| Op. margin (%) | 16.5 | 14.5 | 15 |
| Net profit | 226.3 | 260 | 360 |
| EPS (Rs) | 9.5 | 10.9 | 15.1 |
| PE (x) | 22.9 | 20 | 14.4 |
| E: Estimates, Source: Analyst reports | |||
And while some of the funds are being generated internally, the company has borrowed around Rs 500 crore. As such it could end up paying around Rs 50-60 crore as interest. However, Basu says the company has managed to negotiate lower interest rates and cash flows, may be better than anticipated.
Also, depreciation which was Rs 34 crore in CY08, could be substantially higher. While there was an increase in debtor days to 141 days in CY08, and some increase in inventories, Basu claims these have been sorted out. While revenues are expected to double between now and 2012, the growth this year could be around 20-25 per cent while the bottom line may see low double digit growth compared with an 18 per cent growth in CY08.
At the current price of Rs 218, the stock trades at just under 19 times estimated 2009 earnings and near term upsides appear to be priced in. However, being a pure T&D play, Areva could be a good bet for the long term.