Seeking revenues from realty

PENNY WISE

Low margins in the air-conditioning business has forced Fedders Lloyd to look at realty to boost its growth prospects.

It is Fedders Lloyd that makes your Rajdhani and Shatabdi rides more enjoyable.

Till recently, this company was operating in a single business""air-conditioning. But it has now diversified and brought other businesses into its fold. It will manufacture engineering goods after merging its associate company PSL Engineering (PSLE) with itself.

Fedders is spreading its wings in the realty sector too. It is undertaking real estate development in both, the commercial as well as the residential space. While venturing into engineering does seem to be a logical move, how realistic is it to start making buildings with a background in air-conditioning equipment?

Considering the fact that the company operates in a niche segment and is poised to take advantage of the growing need for air-conditioning solutions, its foray into real estate development is viewed with scepticism by analysts.

Currently, Fedders derives over 50 per cent of revenue from railways and defence sectors. A meagre 20 per cent comes from the retail segment. Fedders will benefit from Indian Railways' plans to roll out metro railway services in cities like Delhi, Mumbai, Bangalore and Hyderabad.

Fedders recently entered into an agreement with Delhi Metro to indigenously manufacture ACs for metro coaches. Over the next five years, Delhi Metro plans to add around 800 coaches, with each coach having a pair of ACs. These ACs can be priced anywhere between Rs 20 lakh to Rs 25 lakh per unit.

The company also operates in the industrial air-conditioning segment as well. With ambitious retail plans announced by several biggies, including some foreign giants, there would emerge a demand for mobile refrigeration as well as refrigerated warehouses which Fedders can take advantage of.

The company is already in talks with heavy vehicle OEMs (original equipment manufacturers) to manufacture air-conditioners for trucks, buses and other heavy vehicles.

By virtue of the company's focus on high-capacity ACs, its average realisation per unit has gone up significantly in spite of lower volumes sold.

Dwindling margins
As per BRICS PCG estimates, the heating, ventilating and cooling (HVAC) industry is projected to grow at 35 per cent for 2005-06, up from the robust 25 per cent witnessed in 2004-05.

This will drive the market for industrial ACs at an expected 20 per cent CAGR over the next few years. But this kind of growth is not expected for Fedders.

BRICS PCG expects the company to generate just Rs 100 crore for FY06 from the air-conditioning division, Rs 115 crore for FY07 is and Rs 130 crore for FY08 which translates into a dismal growth rate.

The margins in this business too are low. The operating margin is just about 7 per cent and the net profit margin has been around 4 per cent. But as analysts point out, this is the trend across the industry. Hence, it is imperative for the company to scout for more lucrative areas. 
 

MARGINS UNDER PRESSURE
(Rs crore)	Q3FY06	Q2FY06	Q1FY06	Q4FY05
Net Sales	70.93	66.8	63.93	64.32
Q-o-Q growth (%)	6.18	4.49	-0.61	3.41
Operating Profit	5.47	4.32	3.70	4.72
Q-o-Q growth (%)	26.62	16.76	-21.61	6.55
OPM (%)	7.71	6.47	5.79	7.34
Net Profit	3.66	2.66	2.20	2.49
Q-o-Q growth (%)	37.59	20.91	-11.65	-8.46
NPM (%)	5.16	3.98	3.44	3.87

Integrating for growth
To extract full benefits of operational and customer-related synergies, the company is merging PSLE with itself. PSLE manufactures heavy engineering products for defence and turnkey projects.

Thus merging this company with itself seems the logical step for Fedders enabling it to provide a wider range of products to customers.

Both the companies cater to a common customer base and derive a large part of business from government organisations and carry out projects with a high level of customisation. PSLE's current order book stands at Rs 75 crore with an execution period of five-six months.

Analysts expect PSLE to record a net profit of Rs 16.5 crore on revenues of Rs 110 crore in FY06. PSLE is projected to grow at 30 per cent annually after the setting up of its new facility at Pantnagar.

The BRICS PCG report claims that this merger will add to per share earnings and will benefit shareholders of Fedders.

Price pinch
Rising raw material prices are a big concern as they account for a major chunk of the overall cost of production for both the air-conditioning and engineering divisions. Base metals constitute around 85-90 per cent of the raw material cost.

Thus the company's margins would take a severe beating in case their prices rise steeply. However, Fedders is in a good position to cushion itself against this.

The company has always had back-to-back agreements with its customers, wherein the new contract is signed at revised rates considering the metal prices prevailing at that point in time. For the execution period of the contract the company uses derivative instruments to hedge its risk.

Realty beckons
Like many other companies, the realty bug has bitten Fedders Lloyd as well. The company owns a plot in the Kalkaji area of New Delhi, on which it intends to construct a commercial complex. A BRICS PCG report has valued the land at over Rs 260 crore post-development.

Fedders will also be developing residential property in category B cities of Gwalior and Jabalpur.

As per the BRICS PCG report, the company plans to develop 180 acres of land each in these two cities which will generate revenue of Rs 850 crore during the next three years.

Thus analysts find these cities promising given the growing trend of a steep acceleration in real estate prices witnessed in cities with industrial or software parks.

"The move not only makes productive use of a property that the company already holds but also lifts up margins considerably," says an analyst.

Following the PSLE merger and the real-estate business foray, analysts say that the company's prospects will improve significantly. Compared to the low-margin business of the air-conditioning segment, the new consolidated entity will have better profitability as well as added stability, arising from business diversification.

At the current market price of Rs 110.30, the stock trades at 20.8 times its trailing twelve months earnings, while Bluestar trades at 24.7 times and Voltas trades at 35 times. If we assume the value of the Kalkaji land without development at Rs 35 per share and strip that off from the current price, the company enjoys a multiple of just 14.2 for its core business. The stock trades at 17.5, 9 and 6.2 times its expected earnings in FY06, FY07 and FY08.