Emco Q2FY11 Update; Cost overruns continue; REDUCE; Target Rs60 :: Emkay

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Emco Ltd.

Cost overruns continue; Maintain negative view

REDUCE

CMP: Rs 64                                       Target Price: Rs 60

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n     Emco reported yet another huge cost over-runs in its projects business – reieterate that cost over-runs are across the projects (including 765kv PGCIL order – 45% unexecuted)

n     Though mgmt mentioned all the cost over-runs provision is over in this quarter, we do not rule out further negative surprises

n     Transformer business also affected due to (1) rescheduling of deliveries from customer side, (2) competition impacting margins by 7-8%

n     Give benefit of doubt once again to mgmt, assume positive numbers from Q3FY11E onwards; Reiterate negative view on the stock

Yet another qtr of cost overruns

Inspite of revenues increasing by 44% to Rs2.9bn, Emco reported EBITDA loss of

Rs274mn and net loss of Rs286mn – Emco continues to surprise us (negatively!). It was

yet another qtr of huge cost overruns. Management in the concall indicated that the

higher costs during this quarter were due to a provision for the cost overruns on the

project’s order book, however did not provide details/quantum of the provisions. We

reieterate that cost over-runs are across the projects (including 765kv PGCIL Rs5.5bn

order – 45% unexecuted). Though mgmt mentioned all the cost over-runs provision is

over in this quarter, we do not rule out further negative surprises. Transformer business

also affected due to (1) rescheduling of deliveries from customer side and (2)

competition impacting margins by 7-8%.

Give benefit of doubt once again to mgmt and assume positive numbers

from Q3FY11E; thus FY12E earnings unchanged

Even though this qtr was a big negative surprise after mgmt in Q1FY11 concall guided

for positive numbers starting Q2FY11. Yet we give the benefit of doubt once again to

mgmt guiding that cost overruns provision is over now. We assume positive numbers

from Q3FY11E. We have now build in FY11E loss of Rs5.3/Share, implying H2FY11E

earnings of Rs3.2/Share. We have fine-tuned our FY12E numbers but kept earnings

unchanged of Rs4.6/Share.

Highlight increase in net debt by Rs1.9bn in 6months; maintain reduce

Emco had net debt of Rs900mn at the end of FY10 which has increased to Rs2.8bn at

the end of Q2FY11. We reiterate, Emco is grappling with multiple problems (1) payment

delays (choice of wrong orders/customers), (2) inventory built up due to rescheduling of

deliveries (choice of wrong orders/customers), (3) competition across its businesses

(entering into right business at the wrong time - projects) and (4) wrong estimation of

quantitative requirements of a project while bidding (talent crunch). Thus, we maintain

our reduce rating on the stock with a price target of Rs60/share. On the CMP of Rs64,

the stock is trading at 14xFY12E earnings, 0.7xFY12E book value and 7.4xFY12E

EBITDA.