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Greaves Cotton: Buy
Contracts from auto players and the steady improvement in infrastructure equipment division can be expected to drive volumes, post FY-11.
Piaggio is the company's major client.
Vidya Bala
Greaves Cotton recently won a 10-year contract from Tata Motors to supply small diesel engines for the latter's new half-tonne truck. As commercial vehicles enter a boom period, similar contracts from players such as Piaggio point to the business potential for Greaves Cotton, active in the three- and four-wheeler segment used in last mile connectivity.
These contracts and the resultant capacity-additions, together with steady improvement in the infrastructure equipment division, can be expected to significantly drive volumes after FY-11. Investors can consider phased exposures in the stock with a 1-2 year perspective. At the current market price of Rs 95, the stock trades at 13 times its expected per share earnings for FY-12 (financial year end set to change from June to March in the current fiscal), at a discount to larger engine makers.
Boom in light vehicles
Three-wheelers account for 73 per cent of the fleet of small-sized commercial vehicles in India. While the sub-3.5 tonne truck category has clearly established itself as a logistic solution for distribution to towns and villages, growing urbanisation has meant that three- and four-wheeler passenger vehicles are among the most viable options for intra-city passenger travel.
Greaves Cotton is a leading supplier of petrol/diesel engines to the light commercial vehicle segment and derives 55 per cent of its revenues from auto engines. Piaggio, an auto maker with a majority share in the three-wheeler cargo segment, is the company's major client. The stock of Greaves Cotton though, suffered a setback when a couple of years ago, Piaggio announced plans to set up its own engine unit in India. Reports now clarify that the Piaggio's unit would be catering mainly to the two-wheeler segment, which it plans to re-enter besides engines for larger vehicles. The eight-year contract with Piaggio, therefore, appears to be on track.
Nevertheless, Greaves Cotton has quickly addressed the risk arising from Piaggio's new unit by expanding its scope of supply to other original equipment manufacturers (OEMs). With most auto makers other than Force Motors and Bajaj Auto sourcing engines externally, Greaves Cotton has managed to capture orders from leading clients such as Mahindra & Mahindra, Tata Motors and Scooters India, besides 40 other OEMs. In fact, Greaves is the sole supplier for some of the new models of auto makers such as Tata Motors. With the assurance of more clients, the company may be able to meet an eventuality of Piaggio turning a competitor.
A good part of 2011, though, could be a year of capex for the auto division. While the first phase of 80,000 unit expansion catering specifically to Tata may be completed by FY-11, a similar addition is expected in the ensuing year. These additions would expand the company's engine capacity by over 40 per cent to 5,20,000 units by FY-12. With an almost nil debt status and healthy operating cash flows, the company should be able to comfortably meet its expansion plans.
Higher depreciation though may be evident in the coming year.
Pick-up in equipment sales
Improved volumes in the construction equipment segment, following a slump during the downturn, is also likely to provide support to earnings. The company clocked a 12 per cent growth in this division for the year ending June 2010, with concreting equipment (33 per cent growth) boosting the division's growth. The increased capital expenditure of infrastructure companies on fixed assets, namely machinery, also corroborates with the expansion in this division. Technical collaborations with players such as Bomag of Germany and Mitsusbishi Industries may give an edge to the company, what with specialised equipment needed for large-scale/advanced construction activities such as elevated roads and metro rails.
Greaves Cotton also made inroads into the more lucrative earthmoving business last fiscal, with the introduction of wheel loaders and motor graders. These products, being used in multiple infrastructure segments such as roads, irrigation as well as buildings, can be expected to expand its client-base. Innovative products in this segment could have propped up EBITDA margins to over 15 per cent now from 11-12 per cent earlier.
Agricultural equipment is yet another growing division for Greaves Cotton. While this segment, which accounts for 15 per cent of total revenues primarily supplies engine pumpsets and power tillers, mini-agro equipment that allow mechanisation of operations also promise growth. Even as state subsidy has so far been the driving force for investments in agri-equipment, going forward, the need to mechanise as a result of higher labour costs and unavailability of labour (as a result of NREGA) could be a strong reason to push sale of equipment such as power tillers.
Financials
After a poor year ended June 2009, Greaves Cotton bounced back with a 30 per cent growth in sales to Rs 1,347 crore in the June 2010 fiscal. Net profits over this period more than doubled to Rs 118 crore. The momentum was maintained in the September quarter as well, with profits surging by 52 per cent.
While volumes in its mainstay automotive engine business can be expected to remain healthy and drive revenues, any steep input cost pressure could hurt margins, as the company may not be able to command much pricing power from large OEMs.
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