Well engineered

PENNY WISE

McNally is growing the mineral processing segment to help boost its operating margins.

The capital goods index has been a star performer posting a gain of 156.21 per cent last year, much higher than the Sensex gain of 69.96 per cent. The McNally Bharat Engineering stock too has been an outperformer gaining 152 per cent to Rs 132.95.

This may be a good return but there could still be some steam left in the stock. Says an analyst, "Increased focus on high-margin businesses in future should result in better margins."

The 45-year-old engineering company is engaged in material handling and transportation, processing and cleaning of minerals. It also takes on complex lumpsum turnkey contracts, from planning to the commissioning stage.

All of the above come under its projects division, which contributes roughly 80 per cent of the total turnover. The rest is contributed by the products division and the highway division.

The company manufactures various industrial equipment, road construction machinery, water pumps, spare parts for steel and cement plants, ash-handling equipment, port-handling equipment and machinery under its products division.

Its highway division focuses on highway construction, rehabilitation, operations and maintenance.

McNally's products and services are basically utilised by core sector companies involved in power generation, mining, metal producing and ports. Its clientele includes players like West Bengal Power Development Corporation, Neyveli Lignite Corporation, Nalco, Vedanta Aluminium and various port authorities.

McNally competes with TRF, Elecon Engineering, Krupp India and HCC in the material handling business and KHD India, Hind Dorr Oliver, Metso Finland and FFE Minerals & Metals in the material processing business. It has a good sales to net assets ratio of 3.01 vis-a-vis its peers like TRF (2.04) and Elecon (1.69), as in FY05.

This is because it takes assets on lease as and when required. McNally is working on changing its product mix. It plans to focus on the high-margin mineral processing segment, as it is a technology-intensive business with low competition.

Currently, it contributes about 20 per cent to revenues. Going forward, this share is likely to increase considering the expected growth in the mining sector.

The government's emphasis on improving infrastructure and booming real estate activities are expected to lead to high demand for steel.

Further, coal mining by private players due to de-blocking of coal reserves and the government's dream power generation target of additional 1,00,000 MW by 2012 will accelerate investments in coal mining. This will lead to increase in demand for raw materials like iron ore and coal. Thus, McNally's role takes centrestage as mineral processing is expected to see accelerated growth.

The company sits on a healthy order book size of Rs 700 crore, which is 3.5 times its nine-month ended FY06 earnings.

Managing Director Srinivash Singh says, "We expect it (order book) to swell by more than 40 per cent in the next financial year to touch approximately Rs 1,000 crore. We also plan to spend around Rs 20 crore for factory expansion and purchase of equipment." 
 

FINANCIALS
9 months ended FY06 (Rs crore)	TRF	Elecon	Mcnally	Change (%) yoy
Net sales	137.22	255.11	197.64	1.04
Operating profit	9.42	39.90	11.03	38.74
OPM %	6.86	15.64	5.58	152 bps
Net profit	3.02	16.92	3.21	85.55
NPM %	2.20	6.63	1.62	74 bps
EPS (annualised)	10.32	40.63	1.60	-
P/E (Trailing 12 month)	39.77	31.74	83.09	-

Over the nine months, the company's sales have been flat at Rs 197.6 crore with a rise of only 1.04 per cent year on year. However, its operating profit shot up by 38.74 per cent at Rs 11.03 crore and margins improved by 152 bps to 5.58 per cent. The company's net profit zoomed 85.55 per cent and margin improved by 74 bps to 1.62 per cent.

However, in the recently concluded quarter, the company posted better sales growth of 36.23 per cent at Rs 82.65 crore. Operating profit improved by 15.91 per cent at Rs 4.08 crore. Net profit also increased by 33.9 per cent at Rs 1.5 crore. However, margins declined.

At present, the stock is trading at 83.09 times its FY06 earnings. While the near-term valuation may appear stretched, analysts expect the stock to trade at 19.8 times and 12.3 times its FY07E and FY08E earnings, respectively, which appear to be more reasonable.