Engines of growth

PENNY WISE

Kirloskar Oil is enhancing capacity and modernising its plants in anticipation of orders from the booming infrastructure and auto sectors.

The bear hammering in the past few weeks has brought stock prices to attractive levels. Market pundits and fund managers opine that this is the time to scan through a plethora of promising stocks. One such stock is Kirloskar Oil Engines (KOEL).

"If you were to purchase a KOEL share a couple of months back it would have set you back by Rs 300. At current levels (Rs 195.4), one can pick the stock because along with robust business expectations, valuations look encouraging," says an analyst.

This 59 year-old Pune-based company, is one of the leading manufacturers of 5 HP-11,000 HP diesel engines in India. The Rs 1,400 crore company manufactures a range of products like engines, diesel generating sets, engine bearings and valves, and grey iron castings.

The company manufactures products at its Pune, Ahmednagar, Hospet, Nashik and Solapur plants.

KOEL's business is divided into two segments""engine and non-engine. The engine business contributes almost 80 per cent to the company's revenues.

These engines are used for powering agricultural machinery, construction and material handling machinery, marine applications and equipment used by the armed forces.

Within the engine segment, the medium engine category brings in a major chunk of the revenues (68 per cent) followed by small engines (22 per cent) and large engines (10 per cent).

The company is a leading player in the 20 HP-300 HP medium engines category. These are used in agriculture (tractors and pumpsets), power generation and industrial applications like mining, material handling, construction, earth moving, industrial equipment and telecom.

At present, the 500 HP-800 HP engines are procured from Daewoo, Korea but KOEL plans to produce these models from FY08 to make them cost-competitive.

In FY06, the engine segment revenues increased by 33 per cent. Leading OEM clients for industrial engines are JCB, Escorts, Punjab Tractors, L&T, Bharat Earth Movers, Voltas, Godrej and Indfos. KOEL also caters to the Indian Railways, telecom and defence sectors.

The sales of small engines used in pumpsets, concrete mixers, winches and power generation increased by 30 per cent in FY06.

In this category, KOEL is not only churning out products with a lower material content (cost reduction) and better consumer appeal but is also trying to fight stiff competition from the unorganised market by revamping its distribution network.

However, the company has gained an edge over the unorganised players since the enforcement of noise and emission norms for engines by the Central Pollution Control Board in July 2005.

KOEL is a small player in the more than 2,400 HP engines used for power generation by captive power plants and for marine propulsion by the Navy and manufactures them in technical collaboration with SMT Pielstick.

The non-engine segment contributes 20 per cent of the revenues and covers the auto components, castings, fuel oil and power generation businesses. The auto components division comprises engine bearings and engine valves in the ratio of 84:16. Maruti, M&M and

Tata Motors in the domestic market and GM and Ford in the international market are its leading OEM customers. In FY06, delay in arrival of certain imported machinery hampered the growth but with capacity constraints having been cleared, the company expects sales to grow at a CAGR of 15 per cent over the next two years.

KOEL exports engines, pumpsets and generating sets mainly to Africa, the Middle East, and the Asian region. The company's export strategy is to secure OEM contracts in the developed markets, especially Europe and US for tractor and construction equipment engines.

In FY06, exports increased by a stunning 42 per cent at Rs 132 crore. The company has set a Rs 240 crore target for this year.

For FY07, KOEL has planned a capex of about Rs 150 crore which is earmarked for capacity expansion, modernisation and for R&D and product development. The company has recently bagged orders worth Rs 250 crore from shipyards.

The government envisages an investment of Rs 14 lakh crore on infrastructure development of which Rs 5.5 lakh crore will be used for constructing and sprucing up roads, ports, urban and telecom infrastructure in the next six years, according to an Edelweiss Securities report.

With a focus on infrastructure, the demand for industrial engines used for mechanising road and port construction equipment is expected to shoot up.

The demand for gensets at base stations of telecom operators will increase as players such as Bharti, Reliance Communication and VSNL plan expansions to meet the growing demand.

The rising demand for backup power requirement from service-related sectors like telecom and BPO coupled with accelerated growth in the number of large residential projects will bring sustained demand for power application engines.

KOEL, being a leading manufacturer of medium engines, is well positioned to reap the benefits from trends favouring higher equipment usage. The engines segment will continue growing at the current pace over next two-three years driven by demand from power, industrial and marine applications, and exports.

The rapidly growing commercial vehicles and cars market equates to demand for bearings and valves. KOEL recently increased both, its plant and operational capacity to maintain pace with the buoyant environment in the automobile industry and is increasing volumes by focussing on OEMs.

The international demand for Indian engines and auto components is on the rise mainly due to cost advantages. KOEL is trying to cash in on this by providing customised products to its overseas clientele.

At present, exports contribute only 9.5 per cent to the company's revenues but the segment is expected to emerge as a growth driver for the company.

"Our business is growing and exports have also increased. We plan to increase production at our units to be in line with the market demand. Towards this end, we will have to expand our capacities. Today, our plants are virtually running at more than 100 per cent capacity and that is why we need to invest," says a senior company official.

In FY06, the company sales spurted by 21.7 per cent year-on-year at Rs 1,415.45 crore. The operating profit registered a spectacular rise of 65.92 per cent at Rs 125.8 crore and margins jumped by a significant 237 basis points to 8.89 per cent.

Similarly, the net profit shot up by 39.87 per cent at Rs 108.43 crore and margins increased by 99 basis points to 7.66 per cent. 
 

FINANCIALS
FY06 (Rs crore)	KOEL	Cummins  India	Greaves  Cotton	Wartsila  India
Net sales	1415.45	1462.77	872.95	292.07
Operating profit	125.80	203.19	116.14	42.07
O PM(%)	8.89	13.89	13.3	14.4
Net profit	108.43	175.70	81.06	23.59
NPM (%)	7.66	12.01	9.29	8.08
EPS	11.17	8.87	17.16	19.6
CMP (Rs)	195.40	183.20	326.65	298
P/E (x)	17.49	20.65	19.04	15.2

In the March 2006 quarter, sales increased by 21.88 per cent at Rs 418.38 crore. The operating profit increased by 17.72 per cent at Rs 42.66 crore, however, the margins declined by 36 basis points. The net profit recorded a rise of 59.45 per cent at Rs 33.93 crore and margins grew by 191 basis points.

At the current market price the stock of KOEL trades at a P/E of 17.49. The forward multiples look reasonable at 14.78 and 12.06 times its FY07 and FY08 earnings respectively.

With good growth prospects across most of its business segments, KOEL is poised to be a major beneficiary of the upsurge in the infrastructure sector and the auto boom.