Elecon Engineering Limited - A good stock to own

Company Background

Elecon Engineering Limited (EEL) is one of India’s largest manufacturer of Material Handling Equipments (MHE) and Industrial Gears and Power Transmission products. MHE systems primarily comprise of various conveyor systems. EEL is one of the largest manufacturers of industrial gears and was the first company in India to introduce modular design concept, case hardened and ground gear technology. EEL is the gear supplier of choice to core sectors like Sugar, Cement, Steel, Fertilizer, Plastic Extrusion and Rubber. They are the only manufacturers of Vertical Roller Mill Gear for the power and cement industry.

Investment Thesis

Turn around in capex cycle has meant that the order inflow has stabilized. EEC has acquired the Benzler-Radicon business from the David Brown Gear Systems Group for a consideration of ~132cr. The company proposes to fund 80% of the acquisition through debt. That means an additional debt burden of 105 cr. This acquisition provides EEL with access to European markets.

The order book is robust. The outstanding order book position on Jan 31, 2011 is 1690 crores. This includes 420 cr added in Q3 FY11. Out of this, MHE orders are 1350 cr and gears are 340 cr. EEL has also submitted bids worth 5000 cr and expects a hit ratio of 20-25%. With the existing order book, there is good revenue visibility for FY12.

Financials

	FY10	FY09	FY08	FY07	FY06
Sales	1109.36	1030.84	927.85	816.6	507.75
Other Income	18.72	-7.89	0.88	0.89	-0.32
Op Profit	168.45	180.72	154.75	123.75	73.45
EBDIT	187.17	172.83	155.63	124.64	73.13
PBT	94.68	92.05	107.57	87.76	45.48
PAT	66.18	57.45	67.2	54.9	27.88
EPS	7.13	6.19	7.24	17.75	48.85
Depreciation	33.12	22.15	14.2	12.22	9.43
Interest	58.71	58.23	33.86	24.66	18.22
Effective Interest Rate(%)	11.26%	9.83%	8.27%	8.69%	8.86%
Tax	24.14	30.65	31.47	29.5	13.09
Effective Tax rate (%)	25.50%	33.30%	29.26%	33.61%	28.78%

Assets	847.68	867.5	646	471.57	308.41
Networth	326.1	275.4	236.72	187.9	102.67
Debt	521.58	592.1	409.28	283.67	205.74
Net Block	344.34	282.91	177.15	122.27	84.55
Cap WIP	17.88	28.11	15.92	4.47	10.66
Debt/Equit Ratio	1.60	2.15	1.73	1.51	2.00
Book Value	35.12	29.66	25.49	60.76	179.87

Debt-Equity Ratio is likely to go up after the acquisition. Increased debt of 105cr would mean an additional interest outgo of around 10-12 cr.

Net Cash (Operations)	170.11	71.25	-20.22	-62.13	-40.51
Net Cash (Investment)	-60.21	-135.33	-79.32	-40.82	-41.73
Capex	84.32	140.1	80.53	43.75	104.64
Free Cash Flow	85.79	-68.85	-100.75	-105.88	-145.15
FCF/Sales(%)	7.73%	-6.68%	-10.86%	-12.97%	-28.59%

Interestingly, EEL has turned net free cash flow positive in 2010 and has turned positive operational cash flow from 2009 onwards.

Dupont Analysis
OPM(%)	15.18%	17.53%	16.68%	15.15%	14.47%
NPM(%) -- (A)	5.97%	5.57%	7.24%	6.72%	5.49%
Asset turnover(avg) -- (B)	1.31	1.19	1.44	1.73	1.65
RoA(%)	7.81%	6.62%	10.40%	11.64%	9.04%
Financial Leverage -- ( C)	2.60	3.15	2.73	2.51	3.00
RoE(%) -- (=A*B*C)	20.29%	20.86%	28.39%	29.22%	27.15%

Quarterly Results

	Q1	Q2	Q3
Sales	247.17	280.91	302.39
Other Income	0.01	0.4	20.55
Op Profit	37.91	39.96	49.65
EBDIT	37.92	40.36	70.2
PBT	19.16	19.95	48.03
PAT	13.32	14.21	36.82
EPS	1.43	1.53	3.97
Depreciation	8.92	9.75	9.83
Interest	9.85	10.66	12.34
Tax	5.84	5.74	11.21
Effective Tax rate (%)	30.48%	28.77%	23.34%

Risks

Political instability may reduce the pace of infrastructure development and may harm the growth for the company.

Input cost of steel is important for margins and any sudden and large increase in prices may impact margins.

Valuation

Stock is currently at 68.95 (NSE closing price) and PE of 19.34 (based on FY2010 EPS) and 7 (based on TTM EPS of 9.85). So, it cannot be termed as expensive. Expected FY12 EPS is around 11-12, with an estimated PE range of 10-12, the expected price range is Rs 110 – Rs 144.

I would not be surprised if I see atleast a 50% price appreciation in one year. The downside risk seems to be limited to 10%-15%.