High on gas

PENNY WISE

Given the huge untapped opportunity for CNG as an alternative fuel, cylinder maker Everest Kanto stands to gain.

Next to ethanol-blended fuel, the future lies in compressed natural gas (CNG) as an alternative fuel as countries like India and China"�the fastest growing economies"�scout for other avenues of energy resources to keep their growth rates afire.

And, the process of this shift has already begun with the Supreme Court mandate on 28 most polluted cities in India to shift to CNG based vehicles. Even in China, the trend is similar.

All this augurs well for Everest Kanto Cylinder"�the market leader in high pressure industrial gas and CNG cylinders used in automobiles and other applications like medical oxygen, fire fighting and also defence.

The stock has already run up quite sharply giving a yearly return of over 120 per cent and has out-performed the Sensex ever since its listing in December 2005 after the initial public offer. The stock trades at 24 times and 15 times its expected earnings for FY07 and FY08 respectively.

Though analysts are positive about the company's business, they advise to accumalate the stock on declines. Moreover, they attribute the company's high valuation to its market leadership, first-mover advantage, long-term earnings visibility and high margins.

Untapped opportunity...
With measures like countering volatility in crude oil prices and concerns about environmental pollution becoming a top priority globally, countries are looking for alternative avenues for non-polluting energy resources like blending ethanol and jatropha with petrol.

With abundant natutal gas availability, more and more countries are also shifting to CNG (compressed natutal gas) as an alternative fuel. As a result, there is a huge demand-supply gap for CNG based vehicles in India benefitting companies like Everest Kanto.

Till date, only 15 cities out of 28 in India have conformed to the Supreme Court mandate of shifting to CNG for automobiles. So there are still 13 more cities left to be tapped.

Moreover, people are also realising that the cost effectiveness of CNG, as it is cheaper than petrol and diesel, has better mileage. Running costs are also lower by 70 per cent and 40 per cent as compared to petrol and diesel respectively.

CNG stations in India are expected to double by 2010 from the current 350 and the market is growing at 30 per cent annually.

Availability of gas in India is expected to improve further due to fresh capacities coming on-stream in the domestic market (gas discoveries in the Krishna-Godavari basin by Reliance group and Gujarat State Petronet and also by Petronet LNG at Dahej and Kochi) and internationally some time after FY09.

...benefitting players like Everest Kanto
Everest Kanto is the biggest beneficiary as it has the first mover advantage. Moreover, it is the only listed player available in the industry which is currently at a nascent stage, characterised by high entry barriers, superior technology and stringent standards and regulations.

The company is capable of providing a wide range of cylinders spanning from 1-20 litre to as high as 400 litre. It is also a major supplier of cascades to big gas companies like Mahanagar Gas and Indraprastha Gas.

The company has a capacity of 6 lakh tonne in India (with plants in Aurangabad, Tarapur and Gandhidham). Its subsidiary in Dubai, which contributes about 40 per cent of turnover and caters to gas-rich countries like Pakistan, CIS countries, Iran and Iraq, is expected to double its 1 lakh tonne a year capacity by end of this month.

China: the next growth driver
Everest Kanto is on a major expansion spree to cater to the lucrative Chinese market, which is also in a similar growth phase like India's in terms of CNG usage.

China's CNG stations are going to increase from 400 to 1800 by 2010. The number of CNG vehicles in China has increased from 15,000 in 2000 to 130,000 in 2005 and will grow at 30 per cent a year too.

The company has earmarked an investment of $75 million over the next three years to set up a 2 lakh tonne plant initially in FY08 (to be ready by September-October 2007) and scale it up to 5 lakh tonne in FY09 and ultimately to 1.5 million by FY10.

Sixty per cent of the output from the Chinese plant will cater to China, while the rest will be sold in other Asian regions, which is currently being catered to from India. The company has already recently raised $20 million from CLSA Private Equity Management. The company has a goal to have a total capacity of 3 million tonne by 2010.

Growth will continue...
Everest Kanto expects to maintain a growth rate of 50 per cent in the next two years, thanks to 30 per cent growth of automobile CNG market though growth in industrial cylinders will be at a stable rate of 10-12 per cent.

Says Puneet Khurana, director, Everest Kanto, "The company's revenue mix would be more inclined to CNG cylinders rather than the industrial segment unlike the current ratio of 60:40 as most of the expansion is in the CNG space."

In H1FY07, the company's net sales and operating profit grew 84 per cent each to Rs 180 crore and Rs 50 crore, while net profit rose a little lower at 72 per cent to Rs 25 crore due to rise in depreciation and interest costs.

Nevertheless, despite the large capacity, sustainability of margins will be a key challenge for the company though it is confident of maintaining margins by passing on costs.

Prices of raw material"�seamless tubes used in oil exploartion- -have been volatile in the past two years, thanks to limited supply (due to few global and large producers) and high demand for oil exploration. Everest Kanto sources about 85 per cent of such tubes from Tenarice Argentina and the rest from Japan and China. The company wants to reduce the dependence on one supplier gradually. 
 

FINANCIALS
Rs crore	H1FY06	H1FY07	% chg
Net sales	98.00	180.00	83.67
Operating profit	26.39	48.40	83.40
OPM(%)	26.93	26.89	-4 bps
Net profit	14.55	25.08	72.37
NPM (%)	14.85	13.93	-93 bps

...but valuations are high
Says Nirmal Shah, analyst, Alchemy Share and Stock Brokers, "The stock trades at a premium to Sensex's one-year forward rolling P/E given the company's strong visibility and growth prospects in the domestic and international markets (especially China), robust growth in earnings led by huge capacity expansion and sharp improvement in return ratios." Investors can look at the stock at about 650 levels.