Wartsila India: Losing steam

Drop in profitability of power and ship power divisions hit Wartsila

Wartsila India has reported lacklustre results for the December 2005 quarter, with its operating profit falling 42.61 per cent y-o-y to Rs 10.83 crore. This was owing to a drop in segment profitability of its power and ship power divisions.

Also, its operating profit margin has fallen 743 basis points y-o-y to 12.5 per cent in the last quarter. Meanwhile, for its year ended December 2005, the company has seen its operating profit margin slip almost 25 basis points y-o-y to 15.93 per cent.

Wartsila is understood to import a significant portion of its power equipment from the parent's global operations. Senior company officials said that given the current global upturn in capex cycle, their Indian customers have to wait for up to six months to get equipment supplies.

As a result, the company was able to only partially capture the current strong demand for power equipment, with its power division reporting a 9.7 per cent y-o-y growth in segment revenue to Rs 81.4 crore.

Wartsila is typically involved in medium-sized projects of up to 50-75 MW. In addition, the company has been expanding its focus in the maintenance of power plants.

However, like other players in the capital goods sector, operating costs such as staff costs have also risen. As a result, segment profit of the power division fell 36.18 per cent y-o-y to Rs 6.35 crore in the December 2005 quarter.

In addition, the company's ship power division saw its segment profit dipping 78.1 per cent y-o-y to Rs 1.52 crore in the December 2005 quarter.

Wartsila's senior management stressed the cyclical nature of their user industry and that a quarter-on-quarter comparison was not strictly objective. Nevertheless, the shipping power division also saw a 38.36 per cent y-o-y drop in segment profit to Rs 6.73 crore in CY05.

The company is expected to leverage the boom in the power capex cycle. The stock appears reasonably valued at about 18 times trailing 12-month earnings.

Sun Pharma

Sun Pharma plans to hive off its innovative R&D business (covering new chemical entities (NCE) and new drug delivery systems (NDDS)) into a new company.

Sun will also transfer about Rs 250 crore to this company-Rs 50 crore will be by way of fixed assets and about Rs 200 crore will be in cash. Sun spends about 10-11 per cent of its revenues (Rs 1600-1700 crore in FY06) R&D at present.

Of this research budget, about 40 per cent is allocated to the higher-end segment such as NCE and NDDS, which will form the core of the new company.

Sun's strategy is a de-risking exercise for its shareholders, as higher end R&D work typically involves substantial expenditure over several years and returns are uncertain. The company is expected to save about Rs 70 crore in FY07 owing to this spin-off.

However, it is expected to see a moderate increase in its tax rate, as R&D expenses enjoy 150 per cent weighted deduction under the Income Tax Act, say analysts.

Existing Sun Pharma shareholders will also get one share in the new company. Sun Pharma's book value in FY05 was pegged at Rs 61 and this is expected to fall owing to the hive-off.

Nevertheless, an anticipated reduction in R&D expenses has led analysts to raise Sun Pharma's earnings estimates by about 10 per cent to around Rs 33-34 for FY07.

Ballarpur: Average performance

Ballarpur Industries reported 1.43 per cent y-o-y decline in its net sales as pulp sales declined owing to a strike at one of its plants.

Paper, paper products and office supplies revenues, which account for 87 per cent of gross sales, were up 5.83 per cent in the December quarter. Despite the dip in net sales, the company managed to grow its operating profit by 2.4 per cent.

Operating profit margin, however, has grown by 100 basis points y-o-y to 26.69 per cent in the December 2005 quarter, thanks to a tight check on power and fuel costs and that of raw materials. Ballarpur saw 2.7 per cent rise in average paper prices and 3 per cent rise in volumes.

Also, the company is undergoing a restructuring where it will first make APR Packaging a 100 per cent subsidiary, and then merge it with itself. It also plans to hive off its power and real estate businesses into two separate subsidiaries, as well as divest its stake in The Paperbase Company.

It will also introduce a VRS and reduce staff costs. The outlook for paper prices remains positive, and the stock trades at a reasonable 10 times FY06 (June year ending) EPS.